The trust loss measures contained in Schedule 2F of the Income tax Assessment Act 1936 have been the bane of practitioners now for many years. Why? Because of their complexity and lack of flexibility!
The recent amendments enacted under the Tax Laws Amendment (2007 Measures No.4) Act 2007 went some way to alleviating some of the complexities and limitations of the provisions.
However, before celebrations commence you should be aware that the recently elected Federal Government has announced that these amendments will be reversed!!
Why? At this stage, apart form the obvious PR spin of ‘potential for revenue leakage’, we are not sure what the primary drivers are for the reversal or from when the proposed reversal will have effect from.
Below we outline some of the issues the amendments were designed to ‘fix’. Looks like they will be coming back to haunt practitioners.
Family Group
Tax practitioners are familiar with the fact that once a trust makes a family trust election (FTE), or an interposed entity election (IEE) for that matter, the trust is generally limited to distributing to certain entities specifically included in the family group of the individual nominated in the election as the specified individual. If the trustee chooses to distribute outside the family group the trustee becomes liable for family trust distribution tax (FTDT) on the distribution at the top marginal rate.
In addition, where an “outsider” to a family trust distributes income into that trust the income injection test may be breached resulting in deductions against the injected income being disallowed.
An outsider for these purposes includes a person other than a member of the specified individuals family group.
Up until the recent amendments introduced by the Tax Laws Amendment (2007 Measures No.4) Act 2007 that took effect from the 2008 financial year, an individuals family group was defined as follows:
- members of the individual’s family, i.e. the individual’s spouse, a child, grandchild, parent, grandparent, brother, sister, nephew or niece of the individual or of the individual’s spouse, and the spouse of such a child, grandchild, parent, grandparent, brother, sister, nephew or niece;
- the trust covered by the family trust election;
- other trusts, companies, and partnerships covered by an interposed entity election (IEE);
- companies, partnership and trusts where family members and/or elected family trusts of the individual have fixed entitlements to all of the income and capital of the company, partnership and trust;
- certain funds, authorities or institutions in Australia to whom tax deductible gifts may be made;
- certain tax exempt bodies;
- if the primary individual and all the members of his/her family are dead, the estate of the primary individual and the estates of family members; and
- certain interests in small and medium enterprises within the meaning of section 128TK of the ITAA 1936.
As can be seen by the former definition of family group, the definition only included “THE” family trust for which the election had been made as a trust which is in the family group of the individual. The word “the” implies the singular such that where there were two family trusts (Trust ‘A’ and Trust ‘B’) controlled by the same family and where both trusts had made a FTE specifying the same individual, the two trusts were NOT treated as being in the same family group. This meant that they could not distribute to each other without attracting FTDT unless they made IEE’s in respect of each other again specifying the same test person.
The size of the problem multiplied as the number of trusts involved increased. Consider a family with four businesses with a discretionary trust established for each business. If from time to time, over a number of years, these trusts wished to distribute to each other and avoid having to pass the various trust loss tests, a total of 16 elections would be needed - one FTE per trust and an IEE to be made by each trust in respect of the other three trusts!!!
The amendments introduced by the Tax Laws Amendment (2007 Measures No.4) Act 2007 alleviate this paperwork impost as each of the four trusts in the above example will now be in the others family group.
Lack of Revocation
Another issue when a FTE was lodged was the fact that the FTE could not be revoked unless the trust was a fixed trust and certain strict conditions were met. In relation to an IEE there was no ability to revoke.
This inability to revoke caused real practical problems where it was later discovered that an entity did not need to make a FTE and/or IEE. For example, a company wholly owned by family group members is not required to make an IEE but it was common that an IEE would be lodged mainly due to confusion.
This caused a problem if the company was a trading company and a potential purchaser wished to acquire the company’s shares as the company, having made an IEE could not distribute outside the family group of the relevant test individual. This also limited the ability of such a company to implement an employee share acquisition scheme for staff.
Marriage breakdown also caused many headaches where assets held by a family trust were required to be transferred to a former spouse as the definition of “family” for trust loss and FTE purposes did not include a former spouse
As such, any such transfer was subject to FTDT as the definition of “distribution” for trust loss and FTDT purposes is wide enough to capture a transfer property.
So, what are the changes to be repealed?
The new measures applicable from the 2008 financial year and which are to be repealed:
- allow FTEs to be revoked in certain limited circumstances (that is, where the family trust election was not required for the utilisation of tax losses, bad debt deductions or accessing franking credits)
- allow the ’specified individual’ to be varied in certain circumstances
- family trusts that specify the same individual to be included in each other’s family group without the need to make IEEs.
- allow the IEEs to be revoked where the election was made for an entity that was already included in the family group
- broaden the definition of family to include lineal descendants of family members
- ensure that the death of a family member does not by itself result in another family member ceasing to be a member of the family
- allow exempt distributions to former step-children from a FTDT by including them within the definition of ‘family group’
Follow the link below to open the Explanatory Memorandum to the Act outlining the changes in more detail: click here>
Might be time for practitioners to give their professional association a call to follow up the reasoning for the planned reversal of amendments which practitioners and advisers have been placing on their Santa wish list for some time now.
This edition of ‘The Assessment‘ was prepared by Rob Power. If you have any comments in regards to the contents of this edition please feel free to pass them on to Rob at robp@webbmartinconsulting.com.au.
